Want to buy McDonalds (MCD) at below market? Try this covered strangle strategy. (March 20, 2019)
MCD
Today I want to look at McDonald’s ( NYSE: MCD ) and set up an option trade, which is something that I don’t typically do in these Free Chart Videos for no reason other than I just typically don’t do them.
Here’s what we are looking at; this is a stock that is trading in an ever-narrowing range but it is still kind of wide. I could tighten this up like this and this looks like a massive volatility squeeze but we don’t get to make our own charts, we can just look at them. Instead, this is what I am seeing, I am seeing lower highs, higher lows, ultimately it just kind of looks like the stock is ready to pinch. Hopefully, if the market cooperates, move higher. Earnings aren’t for a while, over a month from now.
Here’s the thing, if I am looking at this chart and I am looking to trade this, I am kind of looking at 185.00 as maybe a little bit too risky to enter. But man, if I could have got this thing at 182.00, 180.00 would have been better. But if I could have got this thing right down around here then I would feel better about hanging onto this stock because I am buying it closer to the midline, the 20-day moving average, down here a little bit, and so I can’t just buy this stock, right?
Well, here’s another way that I could do it, TI could effectively accomplish the same thing. I could set up what is called a covered strangle, that requires me to SELL an out of the money call, which is higher than the stock price, we will call this 185.00, and sell an out of the money put, which is LOWER than the stock price. So if I look and say, “You know, for the next few weeks, at least until we get closer to earnings, I kind of feel like McDonald’s is probably going to stay in this range, in between 180.00 and 190.00. Maybe it will fall down a little bit lower but I like McDonald’s and I want to own it.” That is the prerequisite; you have got to want to own it. It has got a decent dividend for a DOW stock, 2.5 percent per year. That’s not enough to get my attention as an investor but it is enough to get a funds attention to want to hold this stock.
So I look at the stock, again, I kind of want to buy it. I just wish I could buy it down here instead. By selling a call what that does is, it sets up a situation where somebody can require me, they can call the stock away from me; they can require me to sell them the stock at 190.00. By selling the put somebody can require me to allow the stock to put to me; to force me to buy the stock at $180.00, that is just basic options strategy. Well, since I am selling I am taking on that obligation. I get my money up front and in return, again, I have to take on the obligation of buying the stock at $180.00. So if this thing goes down to 150.00 I’m not happy. If it stays above 180.00 I am happy because I get to keep the whole thing.
On the other hand, if the stock runs up to $300.00 I am obligated to sell somebody the stock at $190.00. So I am unhappy that way too. If I sell the call and sell the put I incur a lot of risk. If the stock goes below this level I’m at risk. If the stock goes above this level I am at risk; as long as it stays in between I’m good. So I sell this call, I sell this put; the reason it is called a covered strangle as opposed to just a strangle, where you have got an out of the money call and put, is because I buy the stock. So I am effectively riding a covered call with a short put. I am buying the stock at $185.00, I am selling the 190.00 call and I am also selling the 180.00 put. So I am getting double premium.
Now, if the stock falls below 180.00 then I have to take on, for every contract that I sold, I have to buy 100 shares of stock so it’s not free money. When these work correctly it looks like free money but it’s really not. You have to understand that if your put gets assigned then you are going to have to buy 100 shares of stock for each contract that you sold. Assuming you have the juice to do that this is how it works: You are selling the 190.00 call and selling the 180.00 put and the total credit is 247.00, we’ll say it’s 250.00. So you are getting, for every contract that you sell, every call and every put that you sell you are getting a total of $247.00. And so now instead of buying the stock at $185.00 we are effectively buying this stock at 182.50 so we are kind of getting it right in the middle if we apply all of our credit to this trade.
The reason I wanted to point this out to you is right now there are not a lot of stock that are giving you really good entries. A lot of stocks are running but that’s fine if you are already on board great. But if you are looking to buy stocks one way you can do it is buy setting up this type of a covered strangle. Where you get to keep that premium as long as the stock stays within the range here. But since you already own the stock, if the stock runs up above 190.00 you get it called away from you.
Well, think about this, you still get to keep the $2.50 premium that you got when you sold the 190.00 and the 180.00 call and put respectively. But you are also getting $5.00 price appreciation here because you buy the stock at $185.00 and you get to sell it at 190.00. So you total gain on this move, which is just a few weeks or so, your total gain on this is $7.50, which is 4 percent. Now, 4 percent might not be enough to get your attention but when you think of the fact that options are priced for every month throughout the year, you could do this again and again and again and again; 4 percent added to 4 percent added to 4 percent, pretty soon we’re talking about real money.
This is the type of thing that I will do sometimes over at Option Market Mentor so you might want to check that out.
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